CHRIS WALLACE, HOST: Prime Minister Netanyahu, welcome back to "FOX NEWS SUNDAY". There's been a lot of chatter this week about direct talks with the Palestinians, but I want to start with what there is to negotiate. Do you really believe that you can make peace with the Palestinians when Hamas controls Gaza, has a lot of support in the West Bank and won't recognize Israel's right to exist?
PM NETANYAHU: I don't think we can make peace with an organization that seeks our destruction. That's Hamas. But I think we can make peace with the Palestinian Authority. It requires a lot of courage from our side, from me, and it also requires courage from President Mahmoud Abbas, the president of the Palestinian Authority. It's going to be a very tough negotiation, but one that I think our peoples are ripe for.
Is Hamas going to be a part of it? No, as long as it wants to destroy Israel, it's not going to be a part of it. Now, at this point, I could tell you, we'll never negotiate with the Palestinian Authority as long as Hamas is in Gaza. That's not my position. I think we should get on with it and seek to negotiate peace between Israel and the Palestinian Authority. We'll have to deal with Hamas later.
WALLACE: But your foreign minister, Avigdor Liberman, says he sees, quote, "no chance - no chance" of a Palestinian state by 2012.
PM NETANYAHU: Well, you know, there are different views. There are people who have different ideas for a democracy. We're a parliamentary democracy, so people are entitled to have different views. They express them. But I think that there is no substitute for getting into direct talks right now and seeking to break this logger jam, to actually go ahead and try to negotiate a final peace deal...
WALLACE: Do you believe there can be a Palestinian state by 2012?
PM NETANYAHU: I think there can be a solution. It may be implemented over time because time is an important factor of getting the solution, both in terms of security arrangements and other things that would be difficult if they're not allowed to take place over time.
So can we have a negotiated peace? Yes.
Can it be implemented by 2012? I think it's going to take longer than that.
WALLACE: You say it's going to take courage on your part. Are you willing to put East Jerusalem as a possible capital of a Palestinian state on the table?
PM NETANYAHU: Well, we have differences of views with the Palestinians. We want a united city. They have their own views. This is one of the issues that will have to be negotiated. But I think the main point is to get on with it.
You know, somebody asked me today, why don't you negotiate with President Abbas? And I said I've been calling for a year and a quarter - ever since we formed a government - to have this negotiation. And the question I raise is what are we waiting for? What are we wasting more time for. Let's just get on with it.
WALLACE: President Obama and you this week were full of nice words about US-Israeli relations. But I think the real question is did you resolve some of the deep differences that exist between the Unites States and Israel when it comes to some of these issues? So let's get into specifics. Did the president explain why the U.S. signed a U.N. statement in May which singled out Israel's nuclear program and failed to mention Iran?
PM NETANYAHU: He said U.S. policy has not changed. He recognizes Israel's unique circumstances, the size of the vulnerability, the history of the attacks that we've had. And he reiterated in our private session and in the public statement some of the key understandings that we've had on this strategic area. So I think if anyone thought that there was a change of U.S. policy, or daylight, between Israel and the United States on these questions, I think he did a lot to lay that to rest.
WALLACE: Did he explicitly say to you that he accepts Israel's right to nuclear weapons for self-defense?
PM NETANYAHU: Well, we didn't get into that kind of a discussion and I'm not going to get into our confidential discussions.
WALLACE: What about the call which the U.S. endorsed at the U.N. for an international conference - a summit on making the Mideast a nuclear-free zone?
PM NETANYAHU: He said that he would not see Israel joining if it didn't feel comfortable with such a conference. And I think that was an important statement.
As far as a nuclear weapons-free zone, you know, and when the lion lies down with the lamb and you don't need a new lamb every day to satisfy the lion, then we might have this kind of transformation in the Middle East. But so far, you know who's been violating the nuclear non-proliferation pact day and night - those who signed it: Iran, Iraq, Libya. And Iran violates it while calling for Israel's destruction and racing to develop atomic weapons to that end.
So I think we should stay focused on the real problem in the Middle East. It's not Israel. It's these dictatorships that are developing nuclear weapons with the specific goal of wiping Israel away.
WALLACE: Have you and the president resolved the issue of whether you are willing to extend the moratorium on construction of settlements, as part of the Palestinians engaging in direct talks?
PM NETANYAHU: The settlements are an issue that have to be engaged in the final status peace negotiations. That's always been agreed on - along with other issues. I made the exceptional, really extraordinary move, of making a freeze on new construction for 10 months. I did that seven months ago, in order to help the Palestinians get into the talks. They haven't gotten into the talks right now.
Now we're asked to make an extension of this. Look, I think this is the wrong approach. I think we should eliminate all these preconditions and all these excuses and all those demands for entering into direct talks. We should just get into them.
WALLACE: During your meeting with President Obama, you praised the recent round of sanctions, not just the UN, but also the additional sanctions that President Obama signed that the U.S. Congress passed on Iran. But recently, the CIA director, Leon Panetta, said this: "Will it deter them" - speaking of the Iranians - "from their ambitions with regards to a nuclear capability? Probably not." Is Panetta right?
PM NETANYAHU: Probably. He's probably right. I can tell you one thing, that Iran is closer to developing nuclear weapons today than it was a week ago or a month ago or a year ago. It's just moving on with its efforts. And I think there is a great danger to the world, not only to my country, but to the United States, to the Middle East, to the peace, to all of humanity from the prospect that such a regime, that brutalizes its own people, that sponsors terrorism more than any other regime in the world, that this regime acquires atomic bombs is very, very dangerous.
WALLACE: U.S. officials estimate that Iran, perhaps within two years, will have a nuclear warhead it can put on a ballistic missile that can strike Israel, Europe, much of the world. Do you have a deadline in your own mind for how long your willing to let diplomacy play out?
PM NETANYAHU: There's only been one time that Iran actually stopped the program and that was when it feared U.S. military action. So when the president says that he is determined to prevent Iran from developing nuclear weapons and that all options are on the table, I think that's the right statement of policy.
You ask what is our policy? Our policy is very simple: the Jewish state was set up to defend Jewish lives and we always reserve the right to defend ourselves.
WALLACE: Do you have a deadline in your mind for how long you're willing to let diplomacy play out?
PM NETANYAHU: Well, I think that we always reserve the right to defend ourselves.
WALLACE: Do you believe that a nuclear Iran can be contained?
PM NETANYAHU: No. No, I don't. I think that's a mistake. And I think that's a misconception.
WALLACE: So it must be stopped?
PM NETANYAHU: You can't rely on the fact that they'll obey the calculations of cost and benefit that have governed all nuclear powers since the rise of the nuclear age after Hiroshima and Nagasaki. We've had effective nuclear peace for more than half a century because everybody understood the rules. I don't think you can rely on Iran, I don't think you can rely on other radicals like the Taliban - they dispatched al Qaeda to bomb New York and Washington.
What were they thinking? Were they that stupid? They weren't stupid. There is an irrationality here. And there's madness in this method. And we should not allow irrational regimes like Iran to have nuclear weapons. It's the ultimate terrorist threat today…
WALLACE: But I just want to follow your argument. You say that Panetta is probably right, that sanctions won't work. You say flatly that containing a nuclear Iran is impossible. Have you and the president ever discussed the possibility of a military strike?
PM NETANYAHU: I'm not going to get into the confidential discussions. And I'm not confirming anything of the sort. But I am saying that the president's position that all options are on the table might actually have the only real effect on Iran, if they think it's true.
WALLACE: This week, you relaxed restrictions on the goods that you're allowing to go into Gaza. But do you believe that Israel did anything wrong while it was intercepting that ship on May 31st and nine people were killed? Do you believe that there was an excessive use of force?
PM NETANYAHU: Oh, first of all, I think we regret the loss of lives. But I talked to the soldiers. I visited the wounded soldiers. I visited them in the hospital. One of them was shot. These activists, these Turkish radicals clubbed him, knifed him, took one of their weapons and fired at them. They were shot. And unfortunately, people were killed. But they acted in self-defense. Your Coast Guard would do the same. Would you feel that they did a terrible thing...
WALLACE: So no excessive force?
PM NETANYAHU: Certainly force that was used to defend their lives and they acted in self-defense, as I heard it directly from them. But I think we have a credible investigation. You know, in Israel's case, it's a real investigation, a real impartial, professional investigation. And it will come out. All these facts will come out.
WALLACE: And will you enforce the blockade against any other ships that try to test it?
PM NETANYAHU: We are enforcing the security blockade in order to prevent weapons and war materiel from getting into Gaza. I've lifted all the civilian - any civilian goods can enter. I've lifted the civilian blockade.
PM NETANYAHU: So anything can come in - food, medicine, toys, you name it. It can all go freely into Gaza. My policy is simple: weapons out, everything else in.
WALLACE: Finally, you have been dealing with American presidents for the better part of 30 years almost. How do you compare Barack Obama to the others?
PM NETANYAHU: I don't compare people. This is something you leave for biographers. But I can tell you there is a consistent line in all U.S. presidents, from everyone that I met, including President Obama, share what the president called the basic bedrock of this unbreakable bond between Israel and the United States. Israeli prime ministers are also different. Each one of us is different. But we all value the relationship with the United States enormously - enormously. I think America has no better friend and ally than Israel in the world and I'm sure that Israel has no better friend and ally than the United States.
WALLACE: Can you honestly say that Barack Obama supports Israel and understands the threats you face the same way that Reagan and Clinton and the two Bushes did?
PM NETANYAHU: I can tell you that we had a conversation in this meeting in Washington the other day. And a good chunk of it - I'd say about half of it - was devoted to a detailed discussion of Israel's security problems: the problem that when we vacate territory, Iran and its proxy terrorists walk in with rockets. And I explained it in great detail. And I found the president understanding, I found him - he considered this problem. He understands that we need to have a solution for it, and I intend to work with him and I hope with President Abbas, to find a solution so that we can couple security with peace, because that's the only peace that will endure, peace based on security.
I'm prepared to go down this route. I know the president is willing to assist us in this. But I need a partner on the other side. You know, you can't be a trapeze artist that wants to connect with the other guy and there's no one there. I need a Palestinian partner. And President Abbas, I don't know if you can go from trapeze artist to step up to the plate. He's got to step up to the plate.
WALLACE: Prime Minister Netanyahu, thank you so much for talking with us.
PM NETANYAHU: Thank you.